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Possible issues with selling shares in a private company

This article discusses the effect the Financial Markets Conduct Act 2013 (FMA) may have on selling shares in unlisted companies.

There are over 500,000 private companies in New Zealand. Their many shareholders obtained their shares in them either by subscribing to the initial share issue from the issuer or a secondary purchase from an existing shareholder who had failed to find a buyer following the pre-emptive process.

Many of you will own shares in at least one company which were acquired in either, or both, of the above ways. At some point you are likely to want to sell all or some of them. You will want to know the sale process will be efficient and effective.

In most companies you will first have to go through a pre-emptive rights process where the other existing shareholders have a first right to purchase their proportionate entitlement to your shares.

If none of the other shareholders want to buy your shares you then have the right to make an offer to third parties. To do that you will need current financials and appropriate reports (presumably provided by the company for this purpose). You would reasonably expect the company “...to advise, encourage, or knowingly assist you”.

This is a fair assumption having regard to:

  • Your being an offeror making an offer of a financial product of shares in their company to a third party.

  • The need for you to make full disclosure to your offeree(s) in the stipulated form of a Product Disclosure Statement (“PDS”) arises if the company so assists you unless you only make the offer to a person excluded through their circumstances under Schedule 1 of the FMA. — This is something most offerors and/or offerees would see as necessary for the latter to assess the offer, and something that requires company involvement

  • The difficulty for you is to produce this information alone. 

However, many companies are saying that they don’t want to be involved as:

  • They say it is uncertain what they would have to do to fall within the realms ofadvising, encouraging, or knowingly assisting you”.

  • Producing a full Product Disclosure Statement (“PDS”) incurs cost. (This is required where the offer is made to parties who do not fall within the Schedule 1 exemption).

  • If the offer is only to parties excluded under Schedule 1, at least an Information Memorandum [“IM”] will still be required.

  • They don’t want to put themselves to the considerable cost and risk in making such an offer with the possibility of being accused of being involved in possible misleading, deceptive conduct, false, misleading or unsubstantiated representations.

So where does this leave you?

You most likely could not complete a PDS(if required) or IM without the company’s assistance — what sort of material could you alone put together that a prudent offeree would be prepared to rely on without the company’s sign off?

Whilst the Schedule 1 exemption may well be available, are you realistically able to manage that process? And again, are you realistically able put together something that would give any offeree(s) the necessary confidence without a company’s sign off?

You may need only one buyer for your shares. Previously under the Securities Act 1978 (now repealed), there were two further exclusions precluding such disclosure being necessary –viz:

  1. consideration of $200,000 or less in any 12 month period or
  2. the offer was made to six or less persons.

Updated exclusions have been carried through to the FMA (Schedule 1) which now provide for:

  • Any personal (previous contact, professional or other connection, interest shown or minimum $200,000 annual gross income for last two years) offer up to a 20 investor or $2m limit in any 12 month period.

Where to now for the offeror?

  1. They persuade the company (or the company offers) to “...advise, encourage and knowingly assist you in respect of the offer...”
    In which event a PDS will be required for those who do not fall within Schedule 1 and an IM realistically will be required for those who do fall within Schedule 1.
    Whether or not the company will assist in the sale will, in most cases, be dependent upon the attitude of the remaining shareholders and may be relevant to their investment timespan. If the company does assist it is likely to require payment for their services,  or

  2. The company refuses to participate in which event the offeror will still have still to prepare their own IM (if they can) and then ensure that they make the offer only to purchasers who fall within Schedule 1.

What then of the prospective offeree?

  1. If the Company does not assist the offeror what are they likely to receive that they are prepared to rely on before investing – won’t they want to see the Company sign-off on any information provided?

  2. What position might they find themselves in if they become a shareholder and later want to sell? It is likely they would want to see a commitment from the company that it would “...advise, encourage and knowingly assist…”in respect of such an offer at the appropriate time—and to know on what terms, and at whose cost, the company would do that.

I am sure the majority of shareholders holding shares in unlisted companies are totally unaware of these issues which may affect the effective steps they can take to sell their shares in the future.

RELEVANT LEGISLATION

In terms of the Financial Markets Conduct Act 2013 (“the FMA”) a share in a company is an equity security which is a financial product. Under the Securities Act 1978 such equity offerings were required, unless exempted to provide disclosure via a prospectus (now a PDS) to a potential offeree. The FMA provides similarly for disclosure by way of a Product Disclosure Statement – the terms and content of which are prescribed.

S 39 of the FMA provides that an offer of financial products for issue requires disclosure to an investor unless an exemption under Part 1 of Schedule 1 applies and s 40 provides that an offer of financial products for sale requires disclosure under Part 3 only if disclosure is required under Part 2 of Schedule 1. That Schedule provides that:

Disclosure will not be required when the investor is exempted because of Part 1 Schedule 1- which is all about the offerees cirumstances viz matters pertaining to such parties requisite business experience, investment activity criteria, minimum amount of investment, is a close business associate or relative of the offeror or is of less than a specified amount and number of investors.

Cl 32 of Schedule 1 Part 2 provides that disclosure will be required if:

The issuer advises, encourages or knowingly assists the offeror in connection with the offer of financial products or the issuer is the offeror

However this does not apply to the exercise of pre-emptive rights in terms of the constitution of the Company or a pre-emptive rights agreement between the shareholders.

There was a similar provision in the Securities Act 1978 (now repealed) but it had a further 2 exemptions in addition to the highlighted section above:

  1. Consideration does not exceed $200,000 in any 12 months,  or

  2. Offer is not made to more than 6 members of the public or has been made with a view to not being accepted by more than six members of the public.